Once Again, You Ain’t Getting No Coke

Board, Blackboard, Economy, Inflation, Money

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For a long time, I’ve held the opinion that the notion of “anchored inflation expectations” was an absurdity. For one thing, we have no good way to measure inflation expectations: market-based measures don’t reflect consumer expectations, and survey measures are nonsense that mostly reflect an availability bias (i.e., changes in small, frequently-purchased items, especially gasoline, have a much larger impact than large, infrequently-purchased items). There are lots of other biases in inflation perception, some of which I enumerated and discussed in a scholarly-ish article almost a decade ago.

It isn’t that I think that people don’t have inflation expectations, or that they are ‘wrong’ in some sense. It is just that the notion that they are “anchored” is something that is completely unmeasurable and so hypothetical. But many economists believe that hypothesis is necessary to help explain the break-in inflation models around 1992-1993. I think there are better explanations for that break, which don’t require assuming a can opener.

However, recently I have started to reconsider whether there is a way in which behaviors concerning inflation are at least sticky. This is not to say that I think this necessarily has a role in inflation modeling (importantly, because there’s no good way to measure it), but I have definitely seen anecdotally some behaviors that can only be explained by figuring that consumers and producers become at least conditioned to expect low and non-volatile inflation. (Note, if I’m right about it being a conditioned response rather than an anchoring with respect to “strong central bank messaging,” it is useless in explaining the 1992-93 inflation model break because my hypothesis is that it takes a long time to happen).

My thoughts derive from some direct observations I have of actual producer/supplier behavior, from customers of mine and their suppliers, over the last couple of years but especially in response to the latest spike in raw materials prices. When I first began this sort of risk and pricing consulting a few years ago, I was struck at the attitude that one of my customers seemed to have – the customer behaved as if it was a commodity producer facing extremely elastic demand curves, such that they were very convinced that if they raised prices at all, they would lose a huge amount of their business to suppliers in China and India. Their customers of course reinforced this notion by responding to questions about price by saying that “lower prices would be good.”[1] But their product was both higher quality and shorter lead time than that of the competition; yet, they priced it as if only price mattered to their customers. The important point, though, is that they were conditioned to believe that any increase in price would destroy their business.

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